The Unique Payroll Issues and Solutions for a Contingent Workforce

A Broad Look at Payroll and the Use of Contingent Labor

As far back as 2003, an article (The Legal Status of Contingent Workers) observed, "With an increasingly uncertain U.S. economy, companies are encountering growing pressure to transform their payroll expenses from a fixed to a variable cost." Given the global economic events since that article was written, those words seem almost prophetic; especially given the fact that the use of contingent labor continues to rise. In fact, an annual survey of contingent labor management by the Aberdeen Group has seen a steady upswing year over year since 2009; and, as a recent thought piece from the research firm highlights, "The economic downturn of the last decade [has] forced many organizations to re-evaluate their existing workforce in such a way that they continue to meet the needs of their customers and clients, without the same overhead of pre-crisis times".

Fast-forwarding to the most recent statistics, nearly 26% of the average company’s workforce is considered contingent in some sense (a rise of 2% on the previous year); proving that organizations across the globe increasingly rely on temporary labor to achieve their business objectives. Indeed, as Aberdeen research suggests, contingent labor plays a vital role in the achievement of goals and objectives in almost 60% of organizations—a fact that is not only altering the workforce landscape but also that of the industry-specific payroll processes that must support this new employment model. Clearly, contingent labor is a fundamental element of the modern organizational business model, but what are the larger implications for payroll-specific issues such as rates, data, remuneration packages, and legal compliance?

The purpose of this special report is to pinpoint the specific issues relating to payroll that are associated with the use of contingent labor in the workforce—highlighting current tactics and solutions used by organizations worldwide in order to better manage their temporary staff. However, to first complete the current picture, it is worth taking a more detailed look at why the use of contingent labor is increasing and what risks that increase poses.

What is Contingent Labor?

As Aberdeen points out, this rise in contingent labor not only revolves around flexibility, but also definition—citing that usage has further increased due to expansion of “the boundaries of what exactly is considered ‘contingent’ labor”. At one time, the term (often interchangeable with “casual” or “temporary” labor) simply referred to a self-employed individual or an agency-supplied worker. However, this simple definition has become more complex in recent years. Driven by the economy, organizations are finding themselves in the unenviable position of juggling and rearranging workforce cost overheads. This, combined with the flexibility afforded by the internet, has created new categories of work; from on-call to work-at-home to virtual. Further, now (according to Aberdeen’s Christopher Dyer) the label of contingent labor includes:

The Benefits & Risks of Contingent Labor Use

Once defined, questions about contingent labor use invariably turn to risks and rewards. Recent Oracle research (Successfully Executing and Managing a Contingent Workforce Strategy) lists some of the wider advantages to bringing contingent labor into the workforce as:

Faster ramp-up times than individuals new to the job or industry, as they already have many of the skills and experience required;

Consequent reduced recruiting and training costs;

Stronger succession planning due to the likelihood that staffing can be conducted on a “just-in-time” basis;

Diverse sources of interaction for the knowledge workers on a team;

The possibility of attracting, motivating, and retaining high-performing individuals who may not otherwise work in a full-time position;

Proactive planning for the economic impact of expected talent shortages;

Reduced benefit costs; and

Reduced employment/payroll taxes.

The risks however, that come with this set of benefits are steep, and include issues such as: possible wrongful classification of workers according to legislation (with resulting legal penalties); more complicated contractual situations (between the organization, the worker and the agency/vendor); a reluctance to transfer knowledge to employees (i.e. the contractor may feel his/her future work is threatened); and of course the potential conflict between contingent workers and regular employees over work and working conditions. Still, the bottom line advantage that encourages organizations to negotiate these sometimes difficult waters is that flexibility of workforce often equates to an equivalent flexibility of payroll expenditure. The contingent elements of the workforce can be scaled up or down more easily according to business needs; and payment is often through accounts payable rather than regular payroll—facets which can be used to stretch the payroll budget further.

Specific Payroll Issues

By its very nature contingent labor is temporary, and as such its use often encourages the sidestepping of an organization’s regular staffing policies—especially those concerning hiring and performance management. In turn, these actions can raise questions of consistency relating to starting salaries and pay-for-performance (P4P)—both issues that most organizations would just as soon avoid. Of course, as the above-mentioned Oracle report acknowledges, “Compensation with contingent labor can be a tricky area to navigate. On one hand, you have negotiated what is hopefully a fair and equitable price when procuring their labor. On the other hand, if you are tracking their performance and potential to help your organization meet its goals, it is reasonable to assume that discussions could be had for over- and underperforming resources.” From a payroll or remuneration standpoint, the organization’s systems must be able to provide timely and accurate compensation (and compensation data) either through the accounts payable system in financials or directly through the payroll system in HR. The following issues represent the most common payroll-related complications that can arise with contingent labor.

Contingent Labor Payroll Issue #1: Hiring
One of the most fundamental, go-to stats for both HR and payroll is headcount (aka knowing how many workers are in the workforce). However, with contingent labor this simple overview can be lacking because the hiring (or perhaps commissioning is a better term) is often delegated to managers rather than taking place through the usual HR route. While the organization can uncover this information by requesting and reviewing data from their temporary staffing vendors, this does not pick up the independent contractors and consultants sourced directly by managers. Furthermore, as the payment route is often through the finance department’s accounts payable system, the usual payroll reporting functions will also fail to provide the full picture. As such, in order to have a true overview of workforce size and payroll cost, an internal audit may be necessary.

Contingent Labor Payroll Issue #2: Variable Rates of Pay
With freelancers, consultants, and agency staff there are external influences on the rate of pay which can affect the normal organizational pay scales and produce a situation in which contingent workers are paid different amounts than regular employees in similar positions. This is potentially acceptable if the variations reflect differences in responsibility or competence. However, the frequently decentralized approach to hiring mentioned in issue #1 can make monitoring levels of pay either impossible or, at the very least, incredibly time-consuming. Whichever way this differential leans, when it comes to light there can be a negative impact on commitment, loyalty and performance. One solution is to consolidate the hiring process by the internal use of a vendor management system or by outsourcing the management of contingent labor to a managed service provider that specializes in that area. In fact, as an article from Innovative Employee Solutions (Best Practices to Effectively Manage the Contingent Workforce) points out, “Companies [can] also benefit by centralizing their HR administration and eliminating redundant relationships and non-uniform pricing amongst contract workers.”

Contingent Labor Payroll Issue #3: The Employer of Record
For independent contractors such as freelancers and consultants, this is a non-issue. Such workers are stand-alone and are responsible for their own taxes, contributions, benefits, and so on. However, for some other contingent workers, such as those on temporary contracts (and even some internship situations), it may be that the organization itself is classified as the employer of record and is legally responsible for the following:

Payroll processing and funding

Tax deposits and filings

Employment contracts and paperwork

I-9 and E-Verify

Unemployment Insurance

Workers' Compensation

Benefits administration

This set of responsibilities may undermine the very benefits that some organizations are hoping to leverage from using contingent workers. A solution to the situation is to only deal with agencies who act as the employer of record for the workers they place. Alternatively, a number of organizations provide an employer of record service, taking on the contingent workers as W-2 employees on their client’s behalf.

Contingent Labor Payroll Issue #4: Benefits
If the organization is not classified as the employer of record then there is no current federal legal requirement to provide or administer benefits for the worker in question (although there is talk in some states of mandating at that legislative level). However, this absence of provision can become another factor in creating a two-tier workforce. For some organizations this may not cause any difficulty; however, in a situation in which contingent and regular employees are required to work closely and cooperatively, such differences can have a significant impact on team performance. Indeed, as outsourcing provider Innovative Employee Solutions suggests in their article, Capitalizing on the Contingent Workforce, “Companies that offer benefits, such as medical, 401(k), disability and life insurance, etc., to contingent employees have a much greater opportunity to recruit and retain the best, most highly skilled and motivated job candidates. Contingent workers value competitive benefits programs as one of the biggest incentives for accepting a position.”

Contingent Labor Payroll Issue #5: Data & Reporting
In the modern C-level business world of predictive analytics and decision-enhancing metrics, the need for accurate data is paramount. In fact, as Aberdeen reports in their Contingent Labor Survey, 81% of Best-in-Class organizations have the ability to drill-down into their contingent workforce management data for custom analysis. As such, any organization which cannot easily access accurate workforce expenditures is in a counter-productive position that can act to the detriment of strategic decision-making. Hence, with a combined regular and contingent workforce (with contingent workers potentially being sourced via a number of different routes), it is essential to integrate data from all sources; including traditional payroll (though possibly from an outsourced payroll provider), contractors’ invoices, and staffing agencies.

Contingent Labor Payroll Issue #6: Legal Compliance
As the definition of contingent labor broadens, the complexity of labor law compliance similarly deepens. Laws covering tax classification may vary from state to state and usually apply different provisions to contingent workers. One example of federal law which can often trip up an organization is the IRS code which limits 1099 contract workers (i.e. independent contractors) to working no more than 1000 hours per year per client. Going above this 1000 hour mark means a reclassification to W-2 status—resulting in a responsibility on the employing organization for worker’s compensation, disability payments, etc.

External Contingent Payroll Solutions

Of course, managing the payroll implications for a contingent workforce doesn’t always take place in-house. Indeed, the Aberdeen Group’s paper, The 21st Century Contingent Workforce Management Program, cites that, “Technology is a cornerstone of … top-tier performance in managing the flexible workforce [and] two technology solutions stand out: Vendor Management Systems (VMS) and Managed Service Providers (MSP). These two solutions streamline and automate major contingent workforce processes (such as recruitment, placement, etc.) and provide consultative expertise in all phases of the modern program.”

Vendor Management System (VMS): This specialized software application is used to acquire and manage temporary and contract labor—typically including onboarding, time and attendance, invoice/payment tracking, and reporting functions. Because the functionality has been designed specifically with the contingent workforce in mind, for most organizations it represents an improvement on the more traditional workforce management solutions for this type of worker population.

Managed Service Provider (MSP): An MSP is an out¬sourced third party provider that takes responsibility for procuring and managing the contingent workforce on behalf of the client organization (usually using a VMS). It can be a logical next step for the organization that does not wish to (or cannot) manage contingent workers in-house with a VMS.

Independent Contractor Engagement Specialist (ICES): A further option is to use the services of an ICES; a service provider that works with organizations to manage independent contractors (freelancers and consultants) by acting as the Employer of Record for IRS purposes. Having assessed the eligibility of a potential contractor for 1099 status, if they are found to be ineligible, the ICES will hire the worker as their own W-2 employee, subcontracting their services to the client organization.

Contingent Workforce Payroll Issues – Final Thoughts

Contingent labor has come a long way since the simple days of an agency providing temporary staffing for basic support roles. Today, even CEOs and high-level management may be contractors instead of employees, and this wide variety of essential functions require a sophisticated understanding of workforce management issues (especially payroll) for contingent workers. As for the future, Aberdeen’s survey found that, “VMS (89%) and MSP (86%) remain the prominent solutions leveraged by Best-in-Class organizations to support and enhance management of all aspects of the modern contingent workforce umbrella”. However, with the current global economic climate, it would seem that the use of all manner of contingent labor is likely to continue growing for some years to come. As such, no organization using contingent labor can afford to neglect or take for granted these specific payroll and management requirements.

As Aberdeen research suggests, contingent labor plays a vital role in the achievement of goals and objectives in almost 60% of organizations—a fact that is not only altering the workforce landscape but also that of the payroll processes that must support this new employment model.